This is a guest post by John MacIntosh of SeaChange Capital Partners, a nonprofit firm that arranges collaborative growth capital funding for outstanding nonprofits.
By John MacIntosh
I joined SeaChange Capital Partners after a career in venture capital. In my experience on the inside, the venture capital market is a dynamic system where three key “actors” (managers, directors and funders) struggle through a fog of uncertainty with
- closely aligned interests (in terms of mission and time frame);
- a clear delineation of roles, rights and responsibilities; and
- transparency in communication.
The system is supported by trust, explicit contracts, underlying legal and accounting frameworks, and an ecosystem of accountants, lawyers, and intermediaries.
Viewed from the outside, this system has attractive features like “close monitoring”, “supportive funders”, “long-term commitments”, “clear metrics and measures”, “accountability”, and “rigorous due diligence”. Not surprisingly, a number of nonprofit organizations have tried transplanting some of these into their work.
Unfortunately, the transplanting strategy fails to appreciate that these things have emerged and are sustained in the venture capital market because of the more fundamental background context. As “emergent properties,” they cannot be successfully transplanted into the nonprofit world without certain enabling conditions. Moreover, these “things” are verbs describing the actors’ response to their environment, not nouns that can be picked up and used: due diligence is a process, not a checklist; reporting is a ongoing activity, not a “dashboard”; accountability is a function of accepting roles, rights and responsibilities, not something acquiesced to up front; etc.
An alternative to transplanting venture capital strategies to the nonprofit field would be to create – even if artificially and imperfectly – the background conditions that might enable these things to emerge.
Imagine that I’d like my $100 million foundation to function like a venture capital firm.
The transplanting strategy would be to study some leading venture firms, adopt their diligence checklists, investment agreements and dashboards, and exhort my team to “be more active”, “take the long-view” and “think like investors”.
An enabling strategy on the other hand recognizes that since venture capital practices have emerged as-needed to make equity investments, they might also emerge if my foundation were required to make as-equity-like-as-possible grants.
For example, I could construct bylaws limiting my foundation to ten grants each to be funded for twenty years (i.e. effectively perpetual) by the income from $10 million of assets; each grant could be ended early only if another funder took over the remaining obligation; and program officers would have incentives tied to the long-term (5-7 year) performance of grantees.
In response, my foundation might naturally begin to act more venture-like without any explicit directive to do so:
- We would be really careful about due diligence because of the limited number and long-term nature of our grants. We would try to find organizations with missions, values, leadership, directors, and co-funders that we felt confident about over the long-term;
- We would be wary of making grants without governance rights, such as a board seat, restrictions on changes in the mission or leadership, and limits on the growth of the funding base;
- We would be explicit about how to measure the “performance” of each grantee given the requirements of the incentive scheme.
Other features of venture capital might be less likely to emerge:
- Would nonprofits agree to be funded on our terms? Probably only if the funding was meaningful and they had developed real trust in our people. (So to get things done, we would need to behave.)
- Would a secondary market develop for our grants? How would funders reluctant to pay for “overhead” or “capacity building” feel about paying us for our right to make a series of “great” grants in the future? Would we really pay other funders to relieve us of the contractual obligation to make a series of grants to a poorly performing grantee? (Imagine the headlines written by the nattering nabobs of nonprofit negativity!)
- Would the incentive program allow for risk-taking? Would people stick around for 5-7 years? Would the inability to rotate grants leave the team bored and uninspired?
I am confident that enabling venture capital practices would be more successful than transplanting them—but I probably wouldn’t do it. In fact, it seems fanciful to voluntarily restrict my potential activities when the distinctive characteristic of philanthropy is freedom. (If you only have to give away 5%, why agree to do more? If you could otherwise rotate grants and change strategy, why not leave the option open? If measures are imperfect, why make them truly high stakes?)
Unfortunately game theory shows that when self-control and commitment are difficult, “bridge-burning” can be the only viable strategy. (Does anyone doubt these are problems in the nonprofit sector? I struggle with them every day.) Unfortunately, it takes courage, self-knowledge, and conviction about your goals, so I don’t expect a revolution any time soon. Most likely, for-profit practices will continue to be transplanted ad-hoc into often inhospitable terrain with mixed results. But hopefully, a few brave souls will burn some bridges and see what emerges.
Brilliant post, John. The VC properties you reference are “emergent” b/c investment success occurs only under conditions of aligned interests, delineation of roles, rights and responsibilities; and transparency. Though we often think of VCs as cowboys, they’re accountable for their returns to their general and limited partners, so they have to obey the laws of investment physics, whether they like them or not.
By contrast, philanthropy is completely voluntary, so that funders have the “freedom” to ignore unpleasant realities. Even if a particular social outcome requires larger and longer funding, nothing compels donors to face facts. By setting their own benchmarks untethered to independent judgment, funders can continually move the goal posts to wherever the ball happens to land. Self-control and commitment are for suckers.
I wonder, though, if an unappreciated dimension of SIF (to which I’m happy to see SeaChange contributing) and other strategic co-funding efforts is that the collaborative structure reduces the degrees of counter-productive freedom by restricting donor choice. For example, SIF allows private parties to spend federal money any way they want as long as the intermediaries and nonprofit grantees show they understand and respond to the emergent conditions necessary for investment success. If, say, an SIF intermediary wanted to make a 1-year grant without funding the necessary capacity building that itself would take 1 year to complete, couldn’t CNCS reasonably ask for an explanation? Similarly, EMCF’s Growth Capital Aggregation Pilot built a governing structure around a funding consortium in which there’s likely to always be one or more parties willing to keep the others honest. “Courage, self-knowledge and conviction” are more likely to emerge within such an accountable structure.
By recognizing that funders can’t be expected to burn their own bridges, these kinds of co-investment systems might be collectively mature enough to acknowledge that social investments encounter formidable emergent conditions no less than financial investments.
Steve – My thought exercise was about the merits of “unilateral bridge burning” as a strategy to tackle problems of commitment and self-control in the absence of market forces. But you make a good point: entering into a “collective” could be equally effective (e.g. AA) and more psychologically plausible than going it alone. However to be effective such a “collective” needs be long-term and difficult to exit, must require that each participant give up some rights by ceding important decisions to “the group”, and must serve as a shared space of trust where people (or institutions) can candidly debate, discuss and declare their “public reasons” for a particular course of action (think Rawls or Habermas). My suspicion is that most funder “collaboratives” have none of these characteristics (let alone all three) and those that do were created through external pressure (like the SIF?). I hope I’m wrong.
I had an interesting conversation today with a foundation who is launching a venture philanthropy fund to which other donors can contribute. Interestingly, the foundation has a spend down policy. It seems that the spend down policy has acted as a “burned bridge” by forcing them to make a difference now since they can’t keep “trying” in perpetuity.
Great discussion, gents. I posted a further reply on my blog: http://tinyurl.com/33szfo6.